Three Reasons to Avoid DSGR and One Stock to Buy Instead

December 26, 2024 at 04:03 AM EST

DSGR Cover Image

Distribution Solutions has had an impressive run over the past six months as its shares have beaten the S&P 500 by 9.4%. The stock now trades at $35.13, marking a 19.4% gain. This run-up might have investors contemplating their next move.

Is now the time to buy Distribution Solutions, or should you be careful about including it in your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.

We’re glad investors have benefited from the price increase, but we're sitting this one out for now. Here are three reasons why there are better opportunities than DSGR and a stock we'd rather own.

Why Is Distribution Solutions Not Exciting?

Founded in 1952, Distribution Solutions (NASDAQ: DSGR) provides supply chain solutions and distributes industrial, safety, and maintenance products to various industries.

1. Mediocre Free Cash Flow Margin Limits Reinvestment Potential

If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.

Distribution Solutions has shown poor cash profitability over the last four years, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 1.5%, lousy for an industrials business.

Distribution Solutions Trailing 12-Month Free Cash Flow Margin

2. Previous Growth Initiatives Haven’t Paid Off Yet

Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? Enter ROIC, a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).

Distribution Solutions historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 6.6%, somewhat low compared to the best industrials companies that consistently pump out 20%+.

3. High Debt Levels Increase Risk

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

Distribution Solutions’s $841.4 million of debt exceeds the $61.34 million of cash on its balance sheet. Furthermore, its 6× net-debt-to-EBITDA ratio (based on its EBITDA of $121.2 million over the last 12 months) shows the company is overleveraged.

Distribution Solutions Net Cash Position

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Distribution Solutions could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope Distribution Solutions can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Final Judgment

Distribution Solutions isn’t a terrible business, but it doesn’t pass our quality test. With its shares beating the market recently, the stock trades at 21.2× forward price-to-earnings (or $35.13 per share). While this valuation is reasonable, we don’t really see a big opportunity at the moment. We're pretty confident there are more exciting stocks to buy at the moment. We’d suggest looking at Costco, one of Charlie Munger’s all-time favorite businesses.

Stocks We Like More Than Distribution Solutions

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